Margin Trading vs Leverage Trading: Difference Explained
Margin trading and leverage trading belong together and are both in the same area of trading but they have two distinctly different meanings. Margin is the initial capital you deposit in your account and leverage is the added buying power that you broker multiplies to your positions.
In order for margin trading to work there has to be leverage, and for leverage trading to work there has to be margin. Let me explain further. When you trade any financial asset with leverage you need margin capital to access leverage. The more leverage you use the less of your own margin capital you have to add and the more margin you add the less leverage you need to use.
- Margin is the capital required to access leverage
- Leverage is added buying power to your positions
Once you see the difference between margin and leverage it becomes easy to understand the relationship and how you can use margin to choose between different leverage ratios. For example, if you have an account size of $100 and you want to trade with $1000 you need to use 1:10 leverage. However, if you have a $200 account size you only need to use 1:5 leverage. The more margin capital you put up the less leverage is required to reach your position size. Margin ratios are also explained in terms of how many percent of a position is margin capital. In our previous example of the $100 account size, you need a 10% margin to trade with $1000. If you would take this $100 account size and trade with a 1% margin you could access 100 times more capital and trade with a $10.000 position size.
Also read: What is 100x leverage in forex, stocks, crypto?
Margin is the initial capital that you invest to trade with leverage and is the full amount of your account. Trading with leverage means that you borrow money and in order to access this “loan” of cash you need to put down an initial downpayment. This downpayment is the margin that is also seen as your risk capital and it is always your margin that is lost when your trade goes against you. It is also what you earn when you make a profitable trade and all your gains are added to your account balance as margin. Whenever you make a profit you increase your margin and whenever you lose it is deducted.
Another way to see margin is as your collateral capital and works exactly the same way as when you borrow money to buy a house, a car, or to start a business. Every loan has an initial collateral payment that you are required to pay in order to receive a loan. The collateral ratio varies depending on how big your loan is and there is also an interest to be paid back to the lender. Most brokers who offer leverage trading in different financial assets will add extra fees to compensate and these fees are always withdrawn from your margin account. Usually, the fee is calculated for all positions kept overnight and paid at midnight.
Compared to margin, leverage is the borrowed funds you receive after you deposit your margin capital and is the added buying power to your positions. You are free to choose your level, or ratio, of leverage before you open the position. For example, if you choose a leverage ratio of 1:5 you will get access to five times your initial deposit. Let’s say that your initial margin deposit was $500 and if you choose to open a position with a 1:5 leverage ratio, your maximum position size would be 5 x $500 = $2500. In this case, your margin requirement to use this leverage ratio was only 20% which means that you only had to put down 20% of your own capital in order to receive the leverage to open your position.
Leverage is a double-edged sword in the sense that it can be used to increase profits significantly due to the increased purchasing power but it also increases the magnitude of your losses. It will benefit any good trader who is an expert in entering the market at the right time and using the proper risk management tools such as stop-loss or other protections from downside movement.
Many traders wonder, can you lose all your money with leverage trading? While the answer is yes, you can, there are many ways to protect your downside.
In today’s markets, leverage is easily accessible and the ratios keep increasing to match the demand of high-risk traders. Read our guide on how to choose the best leverage for a $10, $20, $50, $100, $200 $500, or $1000 account to learn more.
Also, read our guide on why do brokers provide leverage if you want to dig deeper on the topic.
Initial margin capital
Depending on how much capital you decide to deposit in your investment account you can calculate how much margin you need to use to reach a certain position size. Let’s say that you want to trade $10.000 lots and you deposit $5000 as your initial margin capital you only need to use a 1:2 leverage. Your initial margin capital is what your account is built of and it is what sets the scene for your leverage trading activities. If your initial deposit is big enough you don’t need to use a lot of leverage to trade big positions which reduce the overall risks of leverage trading.
To calculate your full position size you always use your initial margin capital multiplied by the leverage ratio. For example, if your initial deposit is $1000 and you are going to trade with a leverage of 1:20 your maximum position size is $20.000. See the calculation below:
$1000 x 20 = $20.000.
Use our leverage trading calculator to learn how much initial margin capital is required for each position.
The leverage ratio you choose has a direct impact on how much margin you need to add to your position. For example, if you choose a high leverage ratio such as 1:50 you only need to add 2% of your margin capital to the position. This significantly increases the risk of your position but it reduces the overall margin invested. If you choose to use a lower ratio of leverage your margin requirement increases.
Let’s say that you are going to use a 1:5 leverage, then you will need 20% of your own margin capital to open a position. Below is a table that explains further the concept of leverage ratios. I have chosen to add the position size to the left and show you how much of your own margin capital you need to put down for each leverage ratio.
|$200||50% = $100||20% = $40||7.5% = $15||3.75% = $7.5||1.875% = $3.75|
|$1200||50% = $600||20% = $240||7.5% = $90||3.75% = $45||1.875% = $22.5|
|$5000||50% = $2500||20% = $1000||7.5% = $375||3.75% = $187.5||1.875% = $93.75|
As you can see, the higher your leverage ratio is the lower your margin requirement becomes. For example, to open a position of $5000 with a 1:2 leverage ratio you need $2500 but if you use a leverage ratio of 1:60 you only need $93.75 but this is a highly leveraged position.
When you use ratios over 1:100 it is considered a highly leveraged position and your risk is increased significantly. Our guide on strategies for high leverage trading will help you out if you are a complete beginner.
Questions asked by other traders
No, they are not, although they are connected. Margin is the initial investment that allows you to access leverage. When you deposit money in a brokerage account you essentially add margin to access leverage. Leverage is the added buying power that your broker adds to your position.
When you open an account with a stockbroker and invest $200 to trade with 1:20 leverage your initial deposit is margin and the borrowed funds you receive are the leverage. There is a difference between short-term trading and long term leveraged investing.
The difference is the way margin and leverage work. Margin is your own capital that you put down as collateral and leverage is the added capital you get from your broker depending on the leverage ratio you choose. When trading any market you always have to add some of your own money (margin capital) to get access to leverage.